BCE Inc T.BCE

Scotia comments on dividend

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A Christmas Letter to BCE

OUR TAKE: Mixed. With BCE’s stock down close to 35% this year, investors are not hearing any Bells for Christmas. It would be unfair to say that this performance was all self-inflicted (distribution ratio chronically >100%, high leverage etc), but also unfair to say that it was all external (increased regulatory and competitive pressures, rising rates etc). We believe BCE has great assets, a strong corporate culture, and remains the industry bellwether. As external observers, here is our short wish list for Christmas which could help in turning around the situation. 1) Immunize the balance sheet from cash outlays related to future fiber expansions both at Ziply and other possible US acquisitions. 2) Dispose of assets where the rent cost could be lower than the cost of ownership (wireless towers, satellite business, Canadian regulated rural networks). 3) Merge the media assets with Corus in a separate publicly listed company. 4) Cut the dividend in half and 5) Stop the DRIP. While this is a long wish list and some might not be quick (the media offload especially), taking action on points 1 and 2 and especially 4 & 5, could create a material shift in expectations and reposition the company to be on the Nice list next year.

KEY POINTS

Let’s call a spade a spade. BCE does not have a FCF problem; it has a payout ratio one. BCE produces significant and consistent FCFs; even during its elevated FTTH build period, the company continued to produce material FCFs, an important reason why even during the last 2 tumultuous years, its credit spread continued to hold very well. The problem at BCE is that paid dividends are disproportionate to internally generated FCFs, resulting in a chronically high distribution ratio. Without tackling this pain point, we believe all other medications will end up treating the symptoms but not truly tackling the root cause. Our wish list is for the company to cut the dividend in half to provide the needed breathing space to de-lever the balance sheet and more importantly, abolish the DRIP. Yes, the initial period after cutting the dividend could be painful, especially given that the stock has a material retail ownership, but long- term, it should build a much stronger foundation. Do we think the dividend will be cut on February 6th when the company provides its 2025 guidance ? Probably not… the dividend should have been cut when the Ziply acquisition was announced and at this point, unfortunately, cutting the dividend without another material change in the situation of the company could increase the level of scrutiny about the financial health of BCE. Do we think the dividend will eventually get cut ? The answer is yes.

Immunizing the balance sheet from fiber expansions. While we continue to believe that BCE paid too much for Ziply and that the US expansion is exposing it to a new set of risks (see here), it is important going forward to minimize any upcoming FCF requirements related to fiber expansions in the US. We currently bake into our assumptions a $200M yearly capex requirement to expand Ziply’s footprint. If BCE can establish a JV in the US similar to what TMUS and AT&T are doing, this could unlock needed cash flows to accelerate deleveraging and reduce cash outlays for other potential US acquisitions. But this might not be enough.

We also need improved ROIC. Many investors assume that selling towers or other regulated assets is pure financial engineering, but it doesn’t need to be. If structured properly, BCE, TELUS, or Rogers can potentially lock in an acceptable upfront cash payment that in addition to reduced interest expense, could add up to offset agreed upon rents even with a 2% escalator (see background here). Another avenue would be for both Rogers and Bell to divest of their satellite businesses to the same buyer, who could obtain some synergies from consolidating them. This would unlikely include satellite synergies given their current geo-locations.

The Hail Mary wish… vertical disintegration. BCE buying Astral was and remains a thorn to many players in the industry as the largest TV distributor also owns the leading broadcaster. This was never an easy pill for the CRTC to swallow, but what if we can rewind the clock? It is true that BCE is unlikely to be allowed to add to its roster of channels in the present form, but if those same media assets were in the hands of an independent operator, we see decent odds that the CRTC might allow the amalgamation of Corus and Bell Media pending closure or divestiture of one of their 2 conventional channels. Canada needs a strong media operator and Corus on its own is unlikely to survive long- term in its present form. Comcast is doing just that in the US as the company aims to create a media company that has low leverage and which can operate independently after a spin out from Comcast. The dividend cut would be well-timed if done in conjunction with such a transaction...(AT&T’s DirecTV divestiture and dividend cut parallel). We don’t believe BCE is currently open to undertaking such a move but could this occur in 2026 or 2027 ? maybe… it is a Hail Mary wish after all.

What if our wish list gets held up by a Post Canada strike and none of the ideas are executed upon? As we discussed in this note, while the newly announced DRIP will lead to some deleveraging starting in 2027, it will be hard for the company to remove the DRIP without bringing FCF distributions (including lease costs) above 100% before at least 2030 unless there’s a material cut in the dividend. The DRIP will continue to dilute shareholders by $1-1.3B per year and increase future dividend funding needs whenever the DRIP is lifted — a difficult scenario to convince investors to buy into even at depressed multiples. If this situation persists, could BCE become the target of a private equity buyout? BCE’s market cap is currently the same as that of TELUS while having a bigger fiber footprint and broadband customer base. Back in 2007/2008, BCE’s valuation was also very depressed which attracted a few interested parties.

Bottom line, we think BCE continues to have significant advantages to prosper into the future. The next few years will be difficult in Canada from a competitive point of view, but eventually, wireless pricing pressure should improve. It has to, otherwise the smaller players would not be able to remain viable. Hence, to play the long game, BCE has to look inwards, pay out only what it can afford, reduce leverage, improve ROICs, divest of declining assets (media), immunize the balance sheet and wait for improving market dynamics, in our view. We hope our wishlist lands in the right mailbox.

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- Scotia DOES a GOOD JOB LISTING MOST of BCE's CORE PROBLEMS but AVOIDS POINTING OUT the REAL SOURCE of the TROUBLE - the SELF-SERVING INEPT BODs and the COZY and ENTITLED SENIOR MANAGERS who let THINGS ESCALATE to a DESTRUCTIVE LEVEL without TAKING STRONG COUNTER-ACTIONS to SET BCE on a STABLE and ROBUST TRAJECTORY - they are RECKLESSLY DELUSIONAL into 'BELIEVING' that they are TOO